Recent trends in India’s balance of payments appear counter-intuitive, with trends in exports and imports running counter to conventional trade theory. Despite the steady appreciation of the rupee by almost 8 per cent in 2010-11, exports have grown faster than imports. While trade deficit and, by extension, the current account deficit are lower than what conventional wisdom would suggest, the reasons underlying this peculiar behaviour need to be looked at more closely. Indian imports are generally price inelastic, implying that their behaviour does not directly reflect exchange rate movements. This has largely to do with the nature of imports, which are dominated by capital goods, food items and oil. Imports of food, both in terms of quantity and value, have increased over the past year due to lower domestic production and higher prices, reflecting global scarcity. Oil imports have continued to increase because of higher domestic consumption, and an expected hardening of global prices can only push the oil import bill up.
The slowdown in capital goods imports raises some worrisome questions about the pace of industrial growth. This trend dovetails with the generally tepid performance of the manufacturing sector in recent months as reflected in recent Index of Industrial Production (IIP) data. Capital expansion by the private sector has not been robust, which could, in turn, reflect a higher cost of capital and/or lukewarm expectations of future economic prospects. India needs a rapidly growing manufacturing sector for present levels of growth to be both more sustainable and inclusive.
Year-on-year export growth of 26.2 per cent for April to November 2011, despite rupee appreciation, is cause for celebration and points to the success of aggressive government policies to raise India’s export profile. In particular, the establishment of Free Trade Zones, the introduction of schemes such as the Duty Exemption Entitlement Scheme (DEEC), the Export Promotion Capital Goods Scheme (EPCG), the excise duty refund scheme on final products and the decision to expand trade with Africa and Latin America as a hedge against an economic slowdown in traditional trade partners have contributed substantially to export growth.
While these policies need to be persisted with, and even expanded, India needs to assiduously work on changing the composition of its export basket, which is currently dominated by primary products or low value added goods. An export basket which includes a significant share of value added goods is not possible without economy-wide improvements in productivity, where India lags even by developing country standards. Improvements in productivity would be dynamic in that they would engender a virtuous cycle with economy-wide benefits, including lowering the cost of capital due to scale effects.
Recent trends in export growth point to an inherent robustness, which is not predominantly dependent on an undervalued currency. India’s integration with the world by way of increased trade can only be expected to increase in the days ahead. The current account deficit, presently 4.1 per cent of GDP, while admittedly restricting policy headroom should not derail this global engagement. It is the composition of the current account deficit that matters more than its relative size. For this reason, a fall in imports at a time of rising exports is a trend that needs further examination and explanation.
